The Fed and Congress Did Almost Nothing

“US economic output tumbled in the first quarter as businesses cut back sharply, marking the nation’s worst six-month contraction in 51 years…

“The 6.1% annualized decline in gross domestic product came as the home-building sector continued to deteriorate, business investment in buildings and equipment plunged and firms drew down inventories at the fastest pace since the start of the decade.”

But wait…51 years ago was the decline of ’57-’58. According to our sources, that recession – though frightening when it began – only took 3.2% off the nation’s GDP. And it ended after six months.

Perhaps we should look back and see what heroic acts on the part of Congress and the Fed cured that recession so quickly.

What’s this? The record shows that Fed did almost nothing. According to Jim Grant, though the Fed cut its key rate to 2.25%, the total monetary stimulus provided by the Fed during that period amounted to zero. On the fiscal side, however, Congress boosted spending, adding to the deficit the equivalent of 3.2% of GDP.

In other words, faced with an equivalent downturn, the feds of yesteryear cured the recession of ’57-’58 – or it cured itself – with a total exertion of barely one-tenth what they are doing today.

But it was a different world back then. To make a long story short, the great boom was just beginning…the Empire was still rising…its currency was still backed by gold…and its books – both federal government registers and national trade accounts – were in balance.

That was also when Detroit’s invitation to “see the USA in a Chevrolet” still had advertising punch. We remember the ads on television…those sleek new automobiles (Detroit came out with brand new models every year)…with their big tailfins and their wide, comfy ride…tops down…roads open…no seat belts – those were the good old days.

General Motors was the biggest and most profitable automobile company on the planet…an icon of American capitalism and its industrial success.

But what’s this? Today’s news tells us that not only is GM to be nationalized, it and Chrysler are to be taken over by the UAW! Ah…at last…Marx’s dream has come true. The workers – at least those in the United Automobile Workers union – are taking over the means of production. Between the government and the unions, General Motors will be almost entirely in the hands of the sweating proletariat.

To that end, a dear reader wrote in this morning and said: “GM will not disappear. Just a slight change to what it represents: Government Motors.”

Along with the story – in the Financial Times – comes a photo of the UAW on strike in 1937. It’s a ‘sit down’ strike…so we see them sitting down in the factory…comfortably resting on Chevy seats while reading the paper.

But these are the good new days.

Imagine if we’d had to write these daily reckonings during the Eisenhower years. What would we have said? We couldn’t rant about government debt – the feds were running balanced budgets and paying down the debt from WWII. We couldn’t fret about trade deficits either – we were running huge trade surpluses. Nor could we wag our finger at consumer spending and personal debt. People were spending money – but they were earning it. The savings rate was healthy. And total debt stood at only about 150% of GDP. Now it is close to 360%.

What a dreary time. There was nothing and no one for a sensible economist to laugh at. Vice President Richard Nixon pledged to fight the recession of ’57-’58 with “whatever action is necessary to stop the economic downturn and stimulate the recovery of the recession.” But, the government’s efforts were very modest. Besides, it was still 14 years before Nixon took out his knife and stabbed the gold-backed monetary system in the back. Back then, the people were freer…but the government was more constrained. There were still limits on what mischief a reckless government could get up to. A country with a pile of dollars back in the ’50s had no worries. It could turn them in to the U.S. Treasury and receive gold at the statutory rate. Its only risk was that the foreign treasury might run out of gold before it got there. This was no risk in the case of the United States of America – it had cleverly sucked in the majority of the world’s gold in exchange for goods and services (hint…many of them made loud noises) during the two world wars.

But all of that has changed now. No one wants to ‘see the USA in a Chevrolet’ anymore. They prefer BMWs. And hybrids made by the Japanese. Now, the U.S. government runs the biggest deficits in history – intending to buy its way out of a recession that, so far, is no worse than the Eisenhower recession of ’57-’58. Next week, the feds will hold the largest auction of Treasury debt in history. They will raise $71.6 billion…on their way to doubling the U.S. national debt over the next five years. The U.S. savings rate is nowhere near as high as it was in the ’50s and ’60s…but it least it has one. Savings disappeared completely during the final years of the Bubble Epoque. Now, Americans are saving 5% again.

The savings rate in the United States isn’t good for our friends in the Far East. Not at all. In fact, according to Merrill Lynch, China’s economy didn’t grow at all in the last quarter of 2008. And it’s still contracting fast, ever since the start of this year.

If the American and European consumers don’t loosen their grip on their wallets, the Chinese ‘miracle’ could be reversed. And the effects on the battered U.S. economy will be much worse than the impact the Asian currency crisis of 1997 had on the United States.

While Shanghai stocks haven’t yet collapsed anything close to what we’re seeing on this side of the ocean… it won’t be long before they catch up.

And now the poor Chinese sit nervously on 1.4 trillion dollars – wondering what to do with it. They buy a few factories…they cut a few deals. But they cannot readily exchange their dollars – neither for gold nor for anything else that doesn’t have a $ sign on it. As soon as they begin the trade in any substantial volume, the object of their exchange will shoot up in value…while their dollars will plunge.

The total value of all the gold ever mined is only about $4.4 trillion, for example. The United States is still the largest holder…but it has only 8,133 tons of the stuff…for a total value of $240 billion. So, if we did the math right, the Chinese could buy up all the entire U.S. gold reserve and have about $1.2 trillion left to spend.

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.

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